The Regulation Crisis

A few weeks after B.P.’s Deepwater Horizon oil rig blew up and crude started spewing into the Gulf, Ken Salazar, the Secretary of the Interior, ordered the breakup of the Minerals Management Service—the agency that was supposedly in charge of offshore drilling. It was a well-deserved death: during the past decade, M.M.S. officials had let oil companies shortchange the government on oil-lease payments, accepted gifts from industry representatives, and, in some cases, literally slept with the people they were regulating. When the industry protested against proposed new regulations (including rules that might have prevented the B.P. blowout), M.M.S. backed down. Franklin Delano Roosevelt, when he hired the famed stock manipulator Joseph P. Kennedy as the first head of the S.E.C., said, “Set a thief to catch a thief.” M.M.S.’s modus operandi was more like setting a thief to help other thieves get away with the loot.

M.M.S.’s bad behavior was unusually egregious, but it’s hard to think of a recent disaster in the business world that wasn’t abetted by inept regulation. Mining regulators allowed operators like Massey Energy to flout safety rules. Financial regulators let A.I.G. write more than half a trillion dollars of credit-default protection without making a noise. The S.E.C. failed to spot the frauds at Enron and WorldCom, gave Bernie Madoff a clean bill of health, and decided to let Wall Street investment banks take on obscene amounts of leverage, while other regulators ignored myriad signs of fraud and recklessness in the subprime-mortgage market.

These failures weren’t accidents. They were the all too predictable result of the deregulationary fervor that has gripped Washington in recent years, pushing the message that most regulation is unnecessary at best and downright harmful at worst. The result is that agencies have often been led by people skeptical of their own duties. This gave us the worst of both worlds: too little supervision encouraged corporate recklessness, while the existence of these agencies encouraged public complacency.

The obvious problems of graft and the revolving door between government and industry, in other words, were really symptoms of a more fundamental pathology: regulation itself became delegitimatized, seen as little more than the tool of Washington busybodies. This view was exacerbated by the way regulation works in the U.S. Too many regulators, for instance, are political appointees, instead of civil servants. This erodes the kind of institutional identity that helps create esprit de corps, and often leads to politics trumping policy. Congress, meanwhile, often takes a famine-or-feast attitude toward funding, allocating less money when times are good and reinflating regulatory budgets after the inevitable disaster occurs. (In 2006 and 2007, for instance, Congress effectively cut the S.E.C.’s budget, even as the housing bubble was bursting.) This makes it hard for agencies to do consistent work. It also contributes to the sense that regulation is something it’s O.K. to skimp on.

Given that we still spend tens of billions of dollars on regulation every year, it may seem odd that attitudes can matter this much. But the history of regulation both here and abroad suggests that how we think about regulators, and how they think of themselves, has a profound impact on the work they do. The political scientist Daniel Carpenter, in “Reputation and Power,” his magisterial new history of the F.D.A. (one of the few agencies that’s been consistently effective), argues that a key to the F.D.A.’s success has been its staffers’ dedication to protecting and enhancing its reputation for competence and vigilance. That reputation, in turn, has made the companies that the F.D.A. regulates more willing to respect its authority. But that’s a rare success story. In most other cases, as the idea of regulation began to seem less legitimate, regulators became less effective and companies felt more free to ignore them.

The social psychologist Tom Tyler has shown that acceptance of a law’s legitimacy is the key factor in getting people to obey it. So reforming the system isn’t about writing a host of new rules; it’s about elevating the status of regulation and regulators. More money wouldn’t hurt: as the conservative economists George Stigler and Gary Becker point out, paying regulators competitive salaries (as is done, for instance, in Singapore, which has one of the world’s least corrupt, and most efficient, bureaucracies) would attract talent and reduce the temptations of corruption. It would also send a message about the value of what regulators do. That’s important, because what the political theorists Philip Pettit and Geoffrey Brennan have called “the economy of esteem” is crucial to making public service work. Offering regulators the kind of reputational rewards that, say, soldiers or firefighters get will make it easier for them to develop a similar sense of common purpose.

That doesn’t mean that the government needs to start putting out “Men of the S.E.C.” calendars, but it does need to instill in regulators the sense that their actions matter. As Carpenter argues in a recent essay, successful regulation, by filling information gaps and managing risk, fosters confidence in the safety and honesty of markets, which in turn makes them bigger and more robust. The pharmaceutical industry, for instance, would be much smaller if people were seriously worried that they might be poisoned every time they took a new drug. And though executives chafe at financial regulation, the protection it provides makes investors far more likely to hand them money to play with. If we want our regulators to do better, we have to embrace a simple idea: regulation isn’t an obstacle to thriving free markets; it’s a vital part of them. ♦

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